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Number Crunching

Mises Daily: Sunday, November 01, 1998 by

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The field in economics called Industrial Organization is the very foundation of antitrust activity by government. And if you thought antitrust action was little more than one business using government to smash its competitors, The Economist (May 2, 1998) is here to correct you.

According to this publication, it's true that antitrust investigators used to sit around estimating market concentration, dreaming up new possibilities, and forcing the market to conform. But the field is no longer in such an "intellectual backwater." Economists can now supposedly tell how a future merger will affect market prices. How? The development of "computers with extraordinary number-crunching power" has "greatly enhanced the economists' ability to crunch numbers and model behavior."

FTC economists can now plug information into "thousands of equations" and determine if proposed mergers are bad for consumers. Courts have depended on these arguments to block mergers in the last three years, including a proposed merger between Office Depot and Staples. Although thousands of retailers sell office products, the FTC argued that the proposed merger would affect prices in the stores involved in the merger and therefore disallowed the merger. This "new way" of thinking about "competitive behavior" may also be used in the Justice department's current suit against Microsoft.

"Economists can actually model oligopolistic behavior and predict what will happen if [a] merger goes ahead," The Economist assures us. "For the first time, they have the ability to predict whether a merger will raise prices for consumers."

Let's see about that. Fifteen years ago, would any economist, even with the help of today's computers, predicted the success that Microsoft has had? Could any economist today predict what will happen in high tech industries in the next fifteen years—what products will be developed, what the price of those products will be, who will be the dominant firms in the industry? Of course not. Economists cannot predict how a merger will affect prices no matter how extraordinary their computers are.

The current FTC arguments on antitrust enforcement should remind economists of a debate early in this century. Beginning in 1920, in Economic Calculation in the Socialist Commonwealth, Ludwig von Mises explained the impossibility of rational calculation under socialism. The lack of market prices for resources in a socialist economy makes it impossible to allocate resources toward consumer wants in any rational manner.

In a market economy, price signals allow producers to compare the benefits and costs of the limitless number of possible production combinations in order to calculate the optimum set of production plans. Without market prices, there is no way to calculate whether or not a particular production plan is efficient. Therefore, socialism creates economic chaos. Resources are wasted. Consumers are not served.

This was the first time socialists had been challenged to explain how a socialist economy would operate, how resources could be efficiently used, how consumer wants would be satisfied. According to Oskar Lange, "Socialists have certainly good reason to be grateful" to Mises for forcing the socialists to "recognize the importance of an adequate system of economic accounting to guide the allocation of resources in a socialist economy."

They may have been grateful that Mises challenged them on this issue, but they were unable to counter Mises' argument. Socialists asserted that the government could mathematically calculate what goods and services needed to be produced and how they should be produced. Bureaucrats could collect information on production techniques and consumer preferences. This information would be assembled in a system of equations. The development of computers, according to Lange, made it possible to simultaneously solve these equations and provide government planners with the information needed to efficiently plan the economy.

In his great work, Human Action, Mises refuted this argument by pointing out that the allocation of resources in a market economy is determined by the actions of millions of producers and buyers. Mathematical constructions cannot replace market functioning. Assembling information in equations that "model" the economy does "not provide any information about human actions." The economy "cannot be taken into account in a system of equations." Human action cannot be captured by "mathematical symbols." And, a planned economy "is just a system of groping about in the dark."

Mises showed that any bureaucratic use of a set of equations to plan the economy would fail. In spite of Mises' warning, today's FTC bureaucrats believe they know what prices will be if they interfere with the market.

Mises was right. Socialism was not an economic system. It was chaos. His argument should be a warning to bureaucrats today who think they can calculate and plan the economy better than the market can. As Mises said, "It is vain to meditate what prices would have been if some of their determinants had been different. Such fantastic designs are no more sensible than whimsical speculations...It is no less vain to ponder on what prices ought to be."

Bureaucrats know neither what prices will be if a merger occurs or more importantly what prices ought to be. Socialists were wrong about their ability to plan their economies and today the FTC is wrong to think that it knows what the appropriate market price is.

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Mark Brandly, a Rothbard fellow of the Mises Institute, teaches economics at Ball State University.